Can Indian IT tide over growth crisis as US plans to tighten H-1B work visa regime?

US proposals to tighten the H-1B work visa regime for foreign professionals on the pretext of protecting American jobs comes as the latest blow to India’s software services industry, which faces potentially higher costs at a time when it is trying to embrace technologies such as cloud computing and artificial intelligence to become more relevant to clients in its biggest market. Photos by Hemant Mishra & Pradeep Gaur/Mint

Bengaluru: India’s software services sector, already struggling with slowing growth, declining profits and questions over its relevance at a time when artificial intelligence and cloud computing are winning wider adoption, should have seen the writing on the wall, given Donald Trump’s “Buy American, Hire American” slogan.

Last month, three bills (one an old one, reintroduced) seeking changes in the way companies in the US hire workers from abroad were put before American lawmakers, triggering alarm in the Indian information technology (IT) industry. And Trump’s administration drafted an executive order proposing to overhaul work-visa regulations.

The alarm was understandable. A prime target of the bills is the H-1B visa regime that governs IT industry professionals and allows companies to hire employees from outside the US to work for up to six years in the country.

Opponents of the regime say that a few companies often abuse the process of hiring foreign workers. These critics say that American workers are losing out in the process because H-1B visa-stamped employees are paid considerably less than US citizens are, and are seeking changes in the H-1B regime.

One of the three bills, introduced in the US House of Representatives, among other things, calls for more than doubling the minimum salary of H-1B visa holders to $130,000, which would make it tough for companies to replace American employees with foreign workers.

India’s $150 billion IT sector has come to accept that changes in the H-1B visa system are inevitable. What industry executives are unsure about is the extent of the impact the changes will have.

“Any legislative changes will take at least a year to become a law,” said a senior executive at Wipro Ltd, India’s third largest IT firm. “Looking at how some of the policy decisions (in the US) are, we’ll not be surprised if an executive order to bring about a change in visas is brought by the President. We need to see the final law before we can say how it will impact us.”

Considering clients in the US account for over half of the revenue of the five largest Indian IT firms, many have questioned the existing business model of these companies that has centred around deploying an army of engineers to write software codes and manage technology infrastructure for their clients in the US and Europe both onside and offsite.

Investors, too, are fretting at these proposed legislative changes: from 1 January 2017 until 6 February, the BSE IT index was down 4.7%, while the benchmark Sensex gained 6.8%.

“The industry, including Wipro, has learnt to hire globally, (hire) many more local employees,” Neemuchwala said in an interview last month. “We have been hiring locally, we have re-badged a lot of employees from our customers. So dependence on visa has absolutely come down over the past few years. And so it is not that much of a worry because we believe (only) business-friendly decisions will be taken by the US government.”

Some analysts agree that Indian technology companies have hired more US citizens in the past few years.

“While several of the US peers (of Indian companies) have a higher percentage of employees in the US comprising locals/green card-holders and have higher absolute US workforces than their India IT counterparts, on an incremental basis, their local employee workforce in the US is dwindling while that for India IT is rising,” JPMorgan Chase and Co. analyst Viju George wrote in a note dated 28 November 2016. “The localization percentage and absolute numbers are still not comparable between the two sets but the trends are in opposite direction.”

Data available on visa requirements by Indian IT firms validate Neemuchwala’s claims. Although none of the top companies, save Infosys Ltd, shares numbers on the workforce in the US or the number of H1-B visa-stamped employees, analysts estimated that homegrown IT firms are less dependent on the visas now. Tata Consultancy Services Ltd (TCS), Infosys, Wipro, HCL Technologies Ltd and Tech Mahindra Ltd got 44% fewer visas in FY15 than in FY12 (see table 1on page 22).

Over the past few years, Indian technology companies (save TCS) have bought many US-based companies, thereby allowing them to increase their workforce. A case in point: about 40% of the 4,851 employees that joined Wipro in the October-December quarter were from Appirio Inc., a US-based cloud services firm that it bought for $500 million.

“The investments in local recruitment in our major markets have allowed us to reduce our dependence on work-visa significantly and to make our business model more resilient,” Rajesh Gopinathan, CEO-designate of TCS, told analysts on 12 January. “As we have mentioned earlier in the call, we applied for a significantly lesser number of visas; in fact, a third of what we had applied for in the prior year and we have been able to actually execute our business model adding 75% fewer visas than what we were used to adding incrementally in a year.”

Until last year, about 8.25% of Infosys’s total employees had H1-B and L1 visas (meant for short-term, non-immigrant workers) stamped, about the same as in 2012 (see table 2 on page 22).

“We are not very convinced that everything which is being done on-site now needs to be done on-site. We have been working on this for over a year; and so, we don’t believe any of the changes proposed will significantly have a negative impact,” an Infosys board member said on condition of anonymity.

Infosys, over the past year, has managed to keep its employee costs at client-facing locations (what it calls on-site) in check.

“On-site employee cost as a percentage of revenue has been in very sharp focus for us. Remember, several years ago, it used to be in the range of 42% of revenue. This quarter, it was 38%, and there is a decline sequentially and year-on-year,” Infosys’s chief financial officer Ranganath D. Mavinakere said in a post-earnings call with analysts on 13 January. “One of the things that delivery teams are doing is that they are looking at all fixed-price projects, looking at the role ratio in those projects, and to see how many of those resources through automation and productivity can be shifted out. That ways we will address both the talent supply part as well as enhancing the margins.”

In the past 12 months, Infosys has brought down the number of employees it calls non-billable staff in client-facing locations. These primarily include employees in human resources and other administration-related functions, helping Infosys retain its operating margin of 25% at the end of the December quarter.

Still, many are worried about the potential of the three proposed laws to hurt IT companies’ business (read growth) as clients may become circumspect about farming out work to Indian companies.

“This (US) is a market where we have been present for the longest duration and many of these customer relationships date back to more than 25-odd years,” Gopinathan said after TCS declared a tepid set of December-quarter earnings last month. “So the customer organizations understand us as a very responsible and long-standing professional firm,” said Gopinathan, adding that the firm will address any concerns “among the newer customers”.

The biggest worry is that any proposed changes in the visa policy could impact the profitability of outsourcing firms. This stems from the fact that at least two of the three bills seek higher pay and want visas to be linked to demand.

The first legislation, called “The High-Skilled Integrity and Fairness Act of 2017”, introduced by (Democrat) California Congresswoman Zoe Lofgren, wants firms to pay a minimum of $130,000 to H-1B visa-stamped employees. The bill also proposes to reserve at least 20% of the current 65,000 H-1B visas issued every year for companies with less than 50 employees. Finally, the bill also proposes that the US government replace the current lottery system with a demand-led model, under which priority for visas will be given to a company ready to pay 200% of the prevailing wage in a region.

A second legislation, called the H-1B and L-1 Visa Reform Act, introduced by Republican Chuck Grassley from Iowa and Democrat Richard Durbin from Illinois, wants the US Citizenship and Immigration Services to prioritize for the first time the annual allocation of H-1B visas.

Some analysts believe many are interpreting the proposed salary increases in the legislation incorrectly.

“The minimum wage level the bills seek to increase is applicable only for applicants seeking exemptions from various compliance obligations (non-displacement of a US citizen, mandatory notifications, etc.,),” Pankaj Kapoor, director of India IT services and software equity research at JM Financial Institutional Securities Ltd, wrote in a 2 February note.

Additionally, over the past few years, employees at Indian IT firms have also seen an increase in salaries (see table 3 on page 22). Although the median salary for employees at all Indian IT firms is still a lot less than the proposed minimum wage increase, most firms do not believe profitability will be hurt significantly.

A senior Infosys executive said on condition of anonymity that the extent of the impact will depend on the minimum wage that’s fixed. “But looking at the current salaries being paid by the firms and the proposed changes being made, we don’t think there will be any major impact on profitability,” added this person.

One thing which is not clear from the proposed changes in the two legislations asking for an increase in the salaries is if it will be applicable only to new visas or even for existing visa-stamped employees.

If the proposed changes are for existing H-1 B employees, too, the profitability of IT companies will take a hit.

“The changes proposed in the allocation method will impact only fresh H-1B visa applicants. Further, the bills do not specify if the proposed changes in minimum wages are for fresh H-1B visa applications or they will impact the renewals/existing holders as well,” Kapoor of JM Financial wrote in his note.

TCS CEO Natarajan Chandrasekaran, chairman-designate of Tata Sons Ltd, told analysts on 12 January that the company targeted a margin band of 26-28%.

“It is a stated intent of the company to remain in that band. The margin target of 26-28% has multiple parameters—employee cost is one of them and in which visas are one of them. The visa situation essentially has two components—one is the quantum of visas and the second one is the cost per resource. So, every time there is a headwind of one of the parameters that goes into the spread sheet, we cannot get panicked and we cannot say it is going to be 300 basis points (bps) or 500 bps and so on and so forth.” One basis point is one-hundredth of a percentage point.

To be sure, Indian IT companies have already started taking the first baby steps towards change, bringing back technology to the core of their business and moving away from being a staffing agency. They have been trying to strengthen their solution offerings in open source technologies and are pushing hard to make their existing workforce re-skill or learn newer technology languages.

The largest companies are investing in building automation or data analytics or artificial intelligence platforms.

Even so, a protectionist administration in the US and the likelihood of more protectionist calls as countries like France and Germany head for elections in 2017 won’t make the process of transition any easier for a sector that has built itself into one of India’s key economic mainstays.